Considering 1031 Exchange funds to purchase a rental for your college bound child to occupy?

As many of us are planning for our children heading off to college in the fall, many of us are considering various questions –

• Which college will my graduating senior decide to attend?
• Will they take a car to school or not?

And one of the most important questions is

• Where will they live?

It is often the case where one our 1031 Exchange clients will decide to exchange a property they currently own into the city where their student will attend college so that they can live in the property purchased through the 1031 Exchange. But, does that qualify as an investment for 1031 treatment?

The 1031 code requires that the property be held for “productive use in a trade or business or for investment.” Does your student occupying the property meet this requirement? Probably not. In this case, this would be considered personal use of the property as your child is part of your family and you are receiving the benefit. Should the IRS ever question this transaction, we do not believe it would meet the requirements for 1031 exchange treatment.

Trying to follow the rules of the 1031, some taxpayers have purchased a 3 bedroom home in the past, having their student occupy 1 bedroom and then they rent out the other 2 bedrooms. In this case, we still believe this would stand up to IRS scrutiny as your family member is still receiving the personal benefit of occupying the property.

In other cases, the 1031 exchangor has rented out all 3 bedrooms (2 to non-family and the last to their child). We have also seen that they family member occupying the home may pay a lower rent if they are also given some management responsibilities of the property. Just remember that it is best practice to have everyone sign a lease to occupy the property, including your child. Also, show your child paying their rent and declare that portion as income along with the rest of the rental income.

As a Qualified Intermediary, we can never give a taxpayer specific tax advice as we would not be filing your taxes at the end of the year. That role will be filled by your tax professional. We strongly encourage that you speak with your own tax person if you are considering a situation like the one described above.

For more information, please reach out to your tax professional for specific questions or contact the specialists here at Security 1^st Exchange for assistance.